Startup Investor School Day 1 Live Stream

Course Structure and Objectives

• Format: The course consists of four days totaling approximately ten hours, structured with lectures followed by Q&A sessions.
• Audience: Open to both accredited and non-accredited investors, with a specific invitation to Y Combinator's Winter 2018 Demo Days (March 19th and 20th).
• Incentives: Ten randomly selected participants from the accredited investor pool are invited to attend the YC Demo Day in person; others receive a virtual invite.
• Feedback Mechanism: Participants are required to complete a post-class survey and may provide real-time feedback via email to Jeff at jeff@ycombinator.com.
• Knowledge Repository: The course aims to create a permanent, open-source resource at investors.startupschool.org for future use, with contributions accepted via startupschool@ycombinator.com.

Strategic Investment Philosophy (Sam Altman)

• Motivation for Angel Investing:
  • Investors should seek "energizing" environments where founders possess unlimited energy and a willingness to attempt things experienced entrepreneurs avoid.
  • The primary driver is the leverage of time: a single successful investment can return 100x to 1,000x, dwarfing the returns of "singles."
  • The most successful investors are those who view investing as a way to help shape the future and are comfortable with a high failure rate.
• The Power Law of Returns:
  • A single best investment will yield a return greater than all other investments combined; the second-best will exceed the sum of all remaining investments.
  • Statistical Evidence: Y Combinator's top five companies represent approximately two-thirds of total value created, while the top single company represents nearly one-third of the total value.
  • Success Metrics: Investors should focus on the magnitude of potential success (home runs) rather than the failure rate; a 95% failure rate is acceptable if one investment returns $1 billion.
  • Decision Framework: The primary question when evaluating a startup should be "How big could this be if it works?" rather than "Why might it fail?"
• Market Identification and Trends:
  • Real vs. Fake Trends: A real trend is characterized by high daily engagement and spontaneous user advocacy (e.g., iPhone early users), whereas fake trends (e.g., current VR) lack habitual usage despite hype.
  • Market Size: Investors should prefer a small market growing rapidly over a large current market that is stagnant or saturated.
  • Competitive Edge: The best investments often occur in markets where the investor understands a specific nuance that the broader market misses.
• Founder Evaluation:
  • Key Traits: Successful founders typically exhibit obsession, focus, frugality, and love for their mission.
  • Intelligence & Creativity: Founders must possess the ability to generate new ideas weekly; intelligence is demonstrated by seeing problems differently.
  • Communication: Strong communication skills are critical for recruiting, fundraising, and evangelizing the product.
  • Execution Speed: Success correlates with the rate of iteration (hypothesis, test, implement) and the ability to make progress between meetings.
  • Growth Rate of the Founder: Investors should assess how quickly a founder improves over time, looking for those on a trajectory to become exceptional leaders.
  • Motivation: Investors must screen for mission-driven founders; those starting companies solely for quick riches or resume building often fail.
  • Red Flags: Founders who lack integrity, cannot be hired into, or treat the startup experience as a social club ("seemsters") should be avoided.
• Investment Process and Mistakes:
  • Herd Mentality: The most common mistake is outsourcing 80% of decision-making to other investors; investors must form independent views to avoid overpaying for trends.
  • Valuation Strategy: The best investments often felt "expensive" or overpriced at the time of investment, whereas strict value investing often misses high-growth outliers.
  • Reputation Management: Founder reputation is the primary currency for winning deals; fighting over terms in failing companies destroys long-term reputation.
  • Product Quality: The best companies are discovered via word-of-mouth without incentives; founders must be able to build a great product, not just grow via sales hacks.

Investment Mechanics and the SAFE Instrument (Carolyn Levy & Kirstie Nathoo)

• The SAFE (Simple Agreement for Future Equity):
  • Definition: A convertible security, not a loan, that converts into stock at a future pricing round; it accrues no interest and has no maturity date.
  • Usage: Designed for very early-stage startups that have not yet issued priced rounds or preferred stock.
  • Simplicity: The document is five pages long with only two key negotiable terms: the investment amount and the valuation cap.
• SAFE Variants:
  • Capped SAFE: Includes a valuation cap (the highest valuation at which the SAFE converts), the most common variant.
  • Discount SAFE: Provides a discount (typically 10–20%) on the share price of the next round rather than a valuation cap.
  • Uncapped SAFE: Has no cap or discount; the SAFE converts at the same price as the new investors (rarely used).
  • MFN (Most Favored Nation) SAFE: Allows the investor to amend their SAFE to match better terms (cap or discount) negotiated with subsequent investors.
• Conversion Mechanics:
  • Pre-Money Conversion: Safes typically convert based on the pre-money valuation, meaning the SAFE shares count toward the capitalization before the new money is added.
  • Ownership Dilution: The final ownership percentage is unknown at signing and depends on the size of the options pool (usually 10% of post-money shares) and the amount of new capital raised.
  • Mathematical Reality: Investors should model scenarios using tools like "AngelCalc" rather than relying on intuition, as human perception of exponential growth is flawed.
• Outcomes and Events:
  • Acquisition (Home Run): The SAFE converts to common stock, and the investor participates in the proceeds alongside founders.
  • Acqui-hire: The SAFE can be elected to be paid off (if proceeds exist) or converted to common stock, depending on the financial outcome.
  • Dissolution/Failure: SAFE holders are next in line to be repaid after trade debts and salaries are settled, though recovery is rarely more than pennies on the dollar.
  • Lifestyle Companies: If a company never raises a priced round, the SAFE remains a security for future equity; investors may need to negotiate a buyback.
• Transaction Process:
  • Handshake Protocol: A written email confirmation of terms ($X at $Y cap) is considered a binding agreement; backing out damages reputation.
  • Execution: Most YC founders use Clerky for e-signing; non-YC founders may use HelloSign, DocuSign, or direct email.
  • Conversion Verification: Investors must review the pro forma cap table to ensure the SAFE conversion math and pro-rata rights are correctly applied.

Practical Advice and Q&A Insights

• Value Add: The primary value an angel provides is hiring assistance and tactical availability (e.g., being reachable for emergency advice).
• Founder Flaws: Investors should not compromise on integrity, but should accept flaws in areas where the founder is improving rapidly (e.g., lack of financial sophistication).
• Legal Structure: For YC and most high-growth startups, the optimal structure is a Delaware C-Corp; LLCs are generally unsuitable for this investment model.
• Global Applicability: SAFEs generally work internationally, though specific country regulations (e.g., India, UK) may require local adaptations.
• Pro-Rata Rights: While standard conversion does not include pro-rata rights, investors can negotiate a side letter to secure the right to invest in future rounds to maintain ownership.
• Liability: Investors investing as individuals face no stockholder liability for corporate debts; legal entities (LLCs) are optional for tax purposes but do not change liability exposure significantly.
• Transparency: Investors should request confirmation of their contractual rights from founders if they suspect a lead investor is ignoring SAFE provisions (e.g., ignoring pro-rata rights).